[Advisory Report on Proposal To Modify the Municipal and Industrial
Water Contractors' Capital and Operation and Maintenance
Deficit Obligations on the Central Valley Project, Bureau of Reclamation]
[From the U.S. Government Printing Office, www.gpo.gov]

Report No. 00-i-281

Title: Advisory Report on Proposal To Modify the Municipal and Industrial
       Water Contractors' Capital and Operation and Maintenance
       Deficit Obligations on the Central Valley Project, Bureau
       of Reclamation



Date:  March 31, 2000




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U.S. Department of the Interior
Office of Inspector General



ADVISORY REPORT
PROPOSAL TO MODIFY THE MUNICIPAL AND INDUSTRIAL WATER
CONTRACTORS' CAPITAL AND OPERATION AND MAINTENANCE DEFICIT
OBLIGATIONS ON THE CENTRAL VALLEY PROJECT, BUREAU OF RECLAMATION


REPORT NO. 00-I-281

MARCH 2000




EXECUTIVE SUMMARY

BACKGROUND

The Central Valley Project, located in California, was authorized
by the Congress in 1937 and built in stages, with initial water
deliveries beginning in 1949 and the last major stage completed
in 1987.  The Bureau of Reclamation (BOR) began delivering
Project municipal and industrial water under terms of individual
40-year water service contracts, which contained "fixed" water
rates.  These water rates were supposed to be sufficient to repay
the Government for BOR's annual operation and maintenance
expenses, annual interest expense on the Government's
construction costs, and an amortized portion of the construction
costs. However, by the 1970s, BOR recognized that the use of
fixed water rates was not producing sufficient revenues to pay
these expenses and that it could not adjust the rates until the
respective contracts expired.  As such, deficit balances were
accruing, which the Government continued to finance.

In 1986, the Congress passed legislation (Public Law 99-546) that
required new or amended Project water service contracts to
contain provisions to ensure that water contractors repay any
outstanding deficits incurred by the Government for their share
of the Project's unpaid expenses. However, according to BOR
officials, the existing water contractors or other parties that
contract for the water supply cannot be held legally responsible
for these amounts until they enter into new or amended contracts.
In October 1994, BOR estimated that municipal and industrial
water revenues will not increase appreciably until 2005, when a
large number of fixed-rate contracts expire and are subject to
renewal.  Based on BOR records, we determined that the
accumulated deficit for all Project municipal and industrial
water contractors was $190 million as of September 30, 1998. 

Prior to February 1999, the Central Valley Project municipal and
industrial water contractors submitted an undated proposal to
modify the amount and computation of the total capital and
operation and maintenance deficit obligations owed the
Government.  The proposal consisted of seven principles, which,
if accepted, would govern the deficit determination for all
Project municipal and industrial water contractors.

OBJECTIVE

The objective of our review was to determine whether BOR's
acceptance of the proposal would be in the best interests of the
Government.

RESULTS IN BRIEF

We concluded that acceptance of the contractors' proposal would
not be in the best interests of the Government in that the
acceptance would provide an unwarranted Federal subsidy to the
Project's water contractors. Specifically, Department of the
Interior and BOR policy applied since 1939 requires water
contractors to repay the actual construction and financing costs
attributable to municipal and industrial water supplies.  Also,
BOR's 1994 Interim Municipal and Industrial Water Ratesetting
Policy, established specifically for the Project and implemented
in accordance with Public Law 99-546, requires BOR to annually
account for any deficit balances to enable it to recover those
costs in the future in accordance with the Public Law.
Furthermore, the Congress, in authorizing water projects under
Reclamation law, has historically provided subsidies to
irrigation water contractors but not to municipal and industrial
water contractors and has not authorized deficits incurred in
operating water projects to be financed by the Government.  Based
on our review of available information, we estimated that if the
proposal is accepted, the repayment obligation of 12 of the
Project's 51 municipal and industrial water contractors would be
reduced by about $114 million and that future interest revenues
would be reduced by about $54 million (present value).  We also
believe that accepting  the proposal could have precedent-setting
impacts on financing and cost-recovery efforts of the Government
and, based on BOR's Denver Office analysis, could cost the
Government billions of dollars.

Additionally, we found that the $190 million Project deficit was
not recorded in BOR's official accounting records and related
financial statements as an amount due the Government.

RECOMMENDATIONS

We recommended that BOR's Commissioner formally reject the water
contractors' proposal in its entirety, inform the appropriate
Congressional committees of any BOR decisions that would
significantly reduce the amount of costs to be recovered from the
water contractors, and properly account for the deficit amounts
associated with the Project in accordance with generally accepted
accounting principles and fully disclose this accounting in BOR's
financial statements beginning with fiscal year 1999.

AUDITEE COMMENTS AND OIG EVALUATION

BOR agreed with the report's three recommendations.  Based on the
response, we considered the recommendations resolved and
implemented.




                                             W-IN-BOR-001-99(A)-D
ADVISORY REPORT


Memorandum

     To:  Commissioner, Bureau of Reclamation

   From:  Roger La Rouche
          Acting Assistant Inspector General for Audits

Subject:  Advisory Report on Proposal To Modify the Municipal and
          Industrial Water Contractors' Capital and Operation and
          Maintenance Deficit Obligations on the Central Valley
          Project, Bureau of Reclamation (No. 00-i-281)

INTRODUCTION

This report presents the results of our review of an undated
proposal made to the Bureau of Reclamation (BOR) by the Central
Valley Project municipal and industrial water contractors to
modify the amount and computation of the total capital and
operation and maintenance deficit obligations owed the
Government.  As of October 29, 1999, BOR had not formally
responded to the proposal. The objective of our review was to
determine whether BOR's acceptance of the proposal would be in
the best interests of the Government.

BACKGROUND

The Central Valley Project, located in California, was authorized
by the Congress in 1937 and built in stages, with initial water
deliveries beginning in 1949 and the last major stage completed
in 1987.  BOR began delivering Project municipal and industrial
water under terms of individual 40-year water service
contracts,[1] which contained "fixed" water rates.  These water
rates were supposed to be sufficient to repay the Government for
(1) BOR's annual operation and maintenance expenses incurred to
deliver the water, (2) the interest expense computed at the
Project rate on the Government's construction costs associated
with building the facilities, and (3) an amortized portion of the
construction costs sufficient to repay the Government's
investment within the Project's repayment period. By the 1970s,
however, BOR recognized that the use of fixed water rates for
Project water deliveries was not producing sufficient revenues to
pay these expenses.  Since the rates were fixed by contract, BOR
could not adjust the rates until the respective contracts
expired.[2]  As such, deficit balances were accruing, which the
Government continued to finance.[3]

From 1949 to 1976, BOR computed interest on the Project's
operating deficits by using the same interest rate (Project rate)
that was applied to the Project's unpaid construction costs.
This rate was 2.5 percent from 1949 to 1973 and gradually
increased to 2.654 percent in 1976.  Beginning in 1983, BOR began
to account for and track the unpaid expenses by individual water
contractor. In 1986, the Congress passed legislation (Public Law
99-546, Section 106) that required BOR to apply U.S.
Treasury-based interest rates to deficits occurring after October
1, 1985. The intent of the legislation was to better reflect the
costs incurred by the Government to continue to finance the
unpaid expenses and the associated annual deficits that were
accruing on the Project.  In addition, Public Law 99-546 required
that new or amended Project water service contracts contain
provisions to ensure that water contractors repay any outstanding
deficits incurred by the Government for their share of the
Project's unpaid expenses. However, according to BOR officials,
the existing water contractors or other parties that contract for
the water supply cannot be held legally responsible for these
amounts until they enter into new or amended contracts.

In October 1994, BOR estimated that municipal and industrial
water revenues would not increase appreciably until 2005, when a
large number of fixed-rate contracts expire and are subject to
renewal.  As such, BOR expects that the deficits will continue to
increase until all the contracts are renewed.  Based on BOR
records, we determined that the accumulated deficit for all
Project municipal and industrial water contractors was $190
million as of September 30, 1998, an increase of $143 million
since 1986.  The deficit balance consists mainly of interest
expense, as shown in Table 1.

----------------------------------------------------
|Table 1.  Central Valley Project Deficit          |
|            as of September 30, 1998              |
----------------------------------------------------
|       |                                 |Amounts*|
|       |                               |(Millions)|
----------------------------------------------------
|Revenues:|Water revenues                 |$128||  |
----------------------------------------------------
|       |Voluntary payments**             |31 | |  |
----------------------------------------------------
|       |  Total revenues               |   | |$159|
----------------------------------------------------
|Expenses:|Operation and maintenance      |51 | |  |
----------------------------------------------------
|       |Capital interest                 |194| |  |
----------------------------------------------------
|       |Deficit interest                 |101| |  |
----------------------------------------------------
|       |Capital repayment                |3  | |  |
----------------------------------------------------
|       | Total expenses                 |   | |349|
----------------------------------------------------
|    Net deficit (total revenues minus|   | |($190)|
|       |total expenses)                  |   | |  |
----------------------------------------------------
|*These amounts represent the revenues and expenses|
|of 41 municipal and industrial water contractors  |
|that, according to BOR records, had a deficit     |
|balance as of September 30, 1998. The remaining 10|
|municipal and industrial water contractors did not|
|have a deficit balance as of that date.           |
----------------------------------------------------
|**Voluntary payments represent amounts paid by    |
|certain contractors in accordance with the Mid-   |
|Pacific Region's August 6, 1992, policy memorandum.|
|This policy allowed municipal and industrial water|
|contractors to pay more than what was required by |
|their water service contracts in order to reduce or|
|eliminate their deficit, which would in turn reduce|
|future accrued interest on their deficit.         |
----------------------------------------------------

In addition to the deficit balances, only about $9 million (2
percent) of the $441 million of construction costs financed by
the Government and allocated to the municipal and industrial
water supply had been repaid by the water contractors as of
September 30, 1998.  As such, the total debt the Government
continues to finance exceeds $622 million for this municipal and
industrial water supply.  The Central Valley Project municipal
and industrial water contractors' proposal consists of seven
principles (see Appendix 2), which, if accepted, would govern the
deficit determination for all Project municipal and industrial
water contractors.

SCOPE

Our review was conducted in September and October 1999, primarily
at BOR's Mid-Pacific Regional Office in Sacramento, California.
We also contacted and interviewed officials from BOR's Washington
and Denver Offices and the Department's Office of the Solicitor
in Washington, D.C.  To meet our objective, we reviewed and
analyzed the contractors' proposal and its impacts in total; the
analyses of the proposal performed by BOR; and applicable laws
(including Reclamation law[4]), policies, and other operating
criteria.  Our analysis and conclusions are presented in the
"Discussion" section of this report.

We conducted our review in accordance with the "Government
Auditing Standards," issued by the Comptroller General of the
United States.  Accordingly, we included such tests of records
and other auditing procedures that were considered necessary
under the circumstances.  Because our review was limited to an
evaluation of the water contractors' proposal, we did not
evaluate BOR's system of internal controls over the recovery of
Project costs.  However, as discussed in the section "Recording
of Project Deficits" in this report, we noted that BOR had not
recorded in its official accounting records or disclosed in its
related financial statements the deficit amounts associated with
this water supply.  As such, we made a recommendation, which, if
implemented, should correct this deficiency.

PRIOR REVIEWS

During the past 5 years, neither the Office of Inspector General
nor the General Accounting Office has issued any reports that
directly related to the objective and scope of our review.

DISCUSSION

We concluded that acceptance of the Central Valley Project
municipal and industrial water contractors' proposal would not be
in the best interests of the Government in that the acceptance
would provide an unwarranted Federal subsidy to the Project's
water contractors. Specifically, Department of the Interior and
BOR policy applied since 1939 requires water contractors to repay
the actual construction and financing costs attributable to
municipal and industrial water supplies.  Also, BOR's 1994
Interim Municipal and Industrial Water Ratesetting Policy,
established specifically for the Project and implemented in
accordance with Public Law 99-546, required BOR to annually
account for any deficit balances to enable it to recover those
costs in the future in accordance with the Public Law.
Furthermore, the Congress, in authorizing water projects under
Reclamation law, has historically provided subsidies to
irrigation water contractors but not to municipal and industrial
water contractors and has not authorized deficits incurred in
operating water projects to be financed by the Government.  Based
on our review of available information, we estimated that if the
proposal is accepted, the repayment obligation of 12 of the
Project's 51 municipal and industrial water contractors would be
reduced by about $114 million (see Appendix 1) and that future
interest revenues would be reduced by about $54 million (present
value[5]).  We also believe that accepting  the proposal could
have precedent-setting impacts on financing and cost-recovery
efforts of the Government and, based on BOR's Denver Office
analysis, could cost the Government billions of dollars.

Recovering Project Costs

Since enactment of the Reclamation Project Act of 1939,[6] it has
been the policy of the Department and BOR to recover actual costs
associated with municipal and industrial water deliveries.  In
1949, the Secretary of the Interior stated that construction
costs allocated to municipal water supplies should be fully
repaid with interest on any unpaid balance and that the rate of
interest used, unless otherwise authorized, should correspond to
the cost of money to the Government.  This policy has been
applied consistently over the years, was reiterated by the
Secretary in 1996, and has been supported by Departmental legal
opinions. For example, a 1947 legal opinion stated that the
Secretary of the Interior can charge interest in a water supply
contract; a 1948 opinion stated that Section 9(c) of the Act
requires repayment of actual construction costs; and a 1980
opinion stated that the Secretary can recover the amount of
interest on money borrowed to operate and maintain facilities.
The 1980 opinion also stated that the Secretary is not limited to
using project interest rates chargeable on the initial investment
capital but instead can set the rate to reflect the current cost
of money borne by the Government to finance the facilities.

Based on long-standing Departmental and BOR policy, we believe
that BOR is clearly authorized to recover the Government's actual
costs, including interest and any past operating deficits,
associated with the delivery of municipal and industrial water.
This position is further supported by Section 106 of Public Law
99-546, which requires that any outstanding Project deficits be
repaid.  To implement this requirement, BOR developed an Interim
Municipal and Industrial Water Ratesetting Policy in 1994, which
requires BOR to annually account for any deficit balances
attributable to each municipal and industrial water contractor to
enable BOR to recover these costs in accordance with the law.
Also, based on our review of Reclamation law, we concluded that
the Congress intended that municipal and industrial water
contractors fully repay the Government's costs associated with
municipal and industrial water deliveries and did not intend that
annual operating deficits be paid by Federal taxpayers.  Although
we found that the Congress has historically provided subsidies to
irrigation water contractors in the form of noninterest-bearing
debt that is subject to their "ability to pay," we did not find
similar provisions for municipal and industrial water
contractors.

In our opinion, acceptance of the Central Valley Project
municipal and industrial water contractors' proposal would not be
in the best interests of the Government because such acceptance
would result in an unwarranted subsidy financed at the expense of
Federal taxpayers.  In that regard, BOR's Mid-Pacific Region
prepared an analysis of the impact that the proposal's seven
principles would have on the computation of the historical
deficit and capital balances as of September 30, 1997.  Following
BOR's methodology, we updated the computations using BOR's annual
accounting of Project deficits as of September 30, 1998.[7]
Accordingly, we estimated that the deficit balances and capital
balances would decrease by about $114 million.  Specifically,
deficit balances would decrease by $71 million, and capital
balances would decrease by $43 million.  In addition, we
estimated that these decreased balances would result in lost
interest revenues amounting to about $119 million over the
Project's repayment period.  These estimated lost revenues have a
present value of about $54 million.[8]  While these estimates
represent a large portion of the dollar impact the principles
would have on the Project deficit through fiscal year 1998, the
dollar effect will be higher because BOR's analysis and our
analysis excluded 39 contractors that would also be affected by
these principles.

In addition to the impact the proposal would have on the
repayment obligation of Central Valley Project water contractors,
an analysis prepared by BOR's Denver Office concluded that BOR
could be subject to similar requests from municipal and
industrial water contractors on all of its projects to waive or
forgive interest charges.  According to BOR's analysis, applying
the contractors' proposal BOR-wide could result in "impacts which
potentially could reach into the billions of dollars."
Similarly, according to BOR's analysis, the Department of Energy
could be subject to requests for the same waiver of interest from
its power contractors.  As such, acceptance of the proposal may
have a substantial impact on the Government's cost recovery
efforts.

Recording Project Deficits

During our review of BOR's records associated with the Central
Valley Project deficits, we identified an accounting issue that
we believe warrants BOR's immediate attention. Specifically, we
found that BOR's Finance and Accounting Services had not recorded
the $190 million Project deficit in BOR's official accounting
records and related financial statements as an amount due the
Government.  BOR officials told us that the deficit was not
recorded as an account receivable because the current water
contractors are not legally required under the terms of their
water service contracts to pay the deficit amounts.  However, as
discussed in the section "Recovering Project Costs" in this
report, the Project deficits will become the obligation of
contractors that enter into new or renewed contracts to receive
future Project water deliveries. Accordingly, as required by
Public Law 99-546, these deficits will ultimately be repaid to
the Government.  As such, we believe that BOR should, at a
minimum, disclose the existence of the Central Valley Project
deficit, report the cumulative amount of the deficit, and state
that the deficit will be repaid by Project water contractors as
required by Public Law 99-546 in a note to its financial
statements.  We also believe that BOR should determine what
amount of the deficit, if any, should be recorded as an account
receivable or recorded in another asset recognition account in
its accounting records, in accordance with generally accepted
accounting principles for the recording of assets.

In conclusion, we believe that BOR should reject the contractors'
proposal because it is not in the best interests of the
Government.  Based on the significant monetary impact involved,
we also believe that any decision which reduces the Government's
recovery of Project costs should be coordinated with appropriate
Congressional committees.

Recommendations

We recommend that the Commissioner, BOR:

1.Formally reject the Central Valley Project municipal and
industrial water contractors' proposal in its entirety.

2.Inform the appropriate Congressional committees of any BOR
decisions that would significantly reduce the amount of costs to
be recovered from Central Valley Project water contractors.

3.Direct Finance and Accounting Services officials to properly
account for the deficit amounts associated with the Central
Valley Project in accordance with generally accepted accounting
principles and fully disclose this accounting in BOR's financial
statements beginning with fiscal year 1999.

BOR Response and Office of Inspector General Reply

In the February 23, 2000, response (Appendix 3) to the draft
report from the BOR Commissioner, BOR concurred with the report's
three recommendations.  Based on the response, we consider the
recommendations resolved and implemented. 

Since the recommendations are considered resolved and
implemented, no further response to this report is required (see
Appendix 4).

Section 5(a) of the Inspector General Act (5 U.S.C. app. 3)
requires the Office of Inspector General to list this report in
its semiannual report to the Congress.  In addition, the Office
of Inspector General provides audit reports to the Congress. 

**FOOTNOTES**

[1]:Water service contracts are authorized by the Reclamation
Project Act of 1939 and essentially sell water on a
rate-per-acre-foot basis.

[2]:According to BOR officials, water contractors were required
to pay only the amount billed under the terms of their respective
contracts and as such were not legally bound to pay any deficit
amount.

[3]:BOR defined deficits as the accumulation of annual operation
and maintenance costs and interest costs in excess of total
revenues received from the sale of water under existing water
service contracts.

[4]:Reclamation law is a term used to refer to the total body of
public laws governing the reclamation program, beginning with the
Reclamation Act of 1902 and including all laws amending and
supplementing the Act.

[5]:Present value is a financial term referring to the time value
of money, which recognizes that $1 received in the future is
worth less than $1 received today.

[6]:Section 9(c) of the Act authorized the Secretary to enter
into water service contracts to provide water for municipal and
industrial purposes at "such rates as in the Secretary's
judgement will produce revenues at least sufficient to cover an
appropriate share of the annual operation and maintenance cost
and an appropriate share of such fixed charges as the Secretary
deems proper."  These fixed charges reflect the interest and
capital costs associated with the construction of the facilities.

[7]:BOR's accounting as of September 30, 1998, is included in the
computation of water rates for the year 2000.  This information
has been released for public comment but had not been finalized
as of October 29, 1999.

[8]:In this analysis, we used the 1998 deficit interest rate of
6.625 percent and assumed that the remaining outstanding
obligations would be amortized in equal installments over the
Project repayment period.

APPENDIX 1 

CLASSIFICATION OF MONETARY AMOUNTS

Finding Area

Funds To Be Put To Better Use

Recovery of Project Costs

Reduction of Future Interest Revenues

Total

$114 million     

54 million*   

$168 million     

*This amount represents our computation, based on U.S. Treasury
rates for 1998, of the present value of the future interest
revenues lost.

APPENDIX 2
Page  1  of  3

SUMMARY OF THE CENTRAL VALLEY PROJECT
CONTRACTORS' PROPOSAL

The Central Valley Project municipal and industrial water
contractors' proposal consists of seven principles, which, if
adopted, would govern the deficit determination for all municipal
and industrial water contractors from the beginning of the
Project through the fiscal year in which a final municipal and
industrial rate-setting policy is adopted.  The principles also
address the transition to a final municipal and industrial
rate-setting policy for the Project. We believe that the seven
principles, taken as a whole, do not protect the interests of the
Government and would provide the contractors with an unwarranted
Federal subsidy.  The seven principles and our opinions on these
principles are as follows:

- Principle 1.  An operation and maintenance deficit would exist
in any fiscal year in which the portion of the Bureau of
Reclamation's (BOR) actual operation and maintenance expenses
(that is, funds appropriated for BOR purposes and expended during
that fiscal year for operation and maintenance of the Project)
allocated to a municipal and industrial water contractor exceeds
revenues from the contractor during that year.

- Office of Inspector General Opinion.  Taken by itself, we
believe that the principle appears reasonable.  However,
operation and maintenance expense is not the only expense that
the municipal and industrial water contractors' revenues were
supposed to cover.  The other expenses include the capital
(construction costs) repayment and the associated interest on
capital that the Government has been financing, in combination
with the operation and maintenance expense, for more than 50
years.  As such, adoption of this principle would be contrary to
long-standing Department of the Interior and BOR policies
regarding repayment of project costs and Congressional intent in
authorizing projects under Reclamation law, which require water
contractors to repay the actual construction and financing costs
attributable to municipal and industrial water supplies.

- Principle 2.  Operation and maintenance deficit balances for
each Project municipal and industrial water contractor would be
determined and would accrue interest in accord with the same
principles that govern Project irrigation operation and
maintenance deficit balances, including those contained in the
1986 statute, the 1988 irrigation rate-setting document, and
other BOR documents applicable to operation and maintenance
deficit balances for Project irrigation water contractors.

- Office of Inspector General Opinion. We believe that this
principle is contrary to BOR policy and Congressional intent of
Reclamation law.  Adoption of this principle would have the
effect of eliminating from the deficit balances all interest on
deficits that occurred before the effective date of Public Law
99-546.  We believe that the deficit balances should properly
include interest computed in accordance with the policies and
Reclamation law in effect at the time that the deficits were
incurred.  This principle would also change the way that
municipal and industrial water revenues are applied.  In
establishing its Interim Municipal and Industrial Water
Ratesetting Policy, BOR stated that it believed that the intent
of Public Law 99-546 was to curtail subsidies to municipal and
industrial water contractors and therefore established a
requirement in the Ratesetting Policy to apply any annual surplus
revenues to the lowest interest-bearing obligation first (the
capital balance).  In contrast, the policy applicable to Project
irrigation water contractors provides for the application of
annual surplus revenues to the highest interest-bearing debt
first (the deficit balance).  In addition, we do not believe that
the Congress intended that municipal and industrial water
contractors be treated the same as irrigation water contractors
with regard to repayment issues, as discussed in the section
"Recovering Project Costs" in this report.

- Principle 3.  Interest on the capital costs allocated to each
municipal and industrial water contractor would be computed at
the appropriate Project composite capital interest rate for each
year.  Balances of any unpaid capital interest would be carried
forward and would not accrue compound interest.

- Office of Inspector General Opinion.  This method for computing
annual capital interest expense is in compliance with existing
BOR policy.  However, the provision stating that compound
interest should not be accrued on unpaid capital interest is a
significant departure from Departmental and BOR policy and
Congressional intent of Reclamation law.

- Principle 4.  The municipal and industrial water contractors
will work with BOR to establish a final municipal and industrial
rate-setting policy which would apply prospectively.

- Office of Inspector General Opinion.  Taken by itself, we
believe that this principle is reasonable as long as Departmental
and BOR policy and Reclamation law are complied with.

- Principle 5.  All future annual deficits (unpaid operation and
maintenance, unpaid capital interest, and unpaid deficit
interest) that arise after implementation of the final municipal
and industrial rate-setting policy would compound at the
"deficit" rate.

- Office of Inspector General Opinion.  Taken by itself, we
believe that adoption of this principle would not reduce the
amount of future cost recovery because this method of computing
deficits and associated interest would be in compliance with
current BOR policy and Reclamation law.  We believe that this
principle is what the Congress intended when it enacted Public
Law 99-546 except that the Congress expected this treatment to be
applied to all water delivery years beginning in 1986.  However,
adoption of this principle in conjunction with the other
principles contained in the proposal would significantly reduce
cost recovery, as discussed in the section "Recovering Project
Costs" in this report.

- Principle 6.  Beginning with the first year of implementation
of the final municipal and industrial rate-setting policy, each
contractor would have the option to pay off its unpaid capital
interest balance and operation and maintenance deficit balance on
the same terms as those given to the irrigation water contractors
for operation and maintenance deficit balances (over a 3 to 5
year period, etc.) or incorporate these balances into future
rates at the "deficit" interest rate.  If a municipal and
industrial water contractor chooses to incorporate these balances
into future rates, BOR would not require them to be paid off as a
condition of contract renewal.

- Office of Inspector General Opinion.  Taken by itself, except
for the reference to the "same terms as those given to the
irrigation water contractors for operation and maintenance
deficit balances," this principle appears reasonable. Since
Reclamation law has historically treated municipal and industrial
water contractors different from irrigation water contractors in
the repayment of the Government's costs associated with water
projects, we believe that BOR has correctly established a
separate repayment policy applicable to municipal and industrial
water contractors.

- Principle 7.  Any voluntary payments made by a contractor would
be applied as directed by the contractor.

- Office of Inspector General Opinion.  Taken by itself, we
believe that this principle is reasonable as long as Departmental
and BOR policy and Reclamation law are complied with.

APPENDIX 3
Page  1  of  3

APPENDIX 4

STATUS OF ADVISORY REPORT RECOMMENDATIONS

Finding/Recommendation
Reference

Status

Action Required

1, 2, and 3

Implemented.

No further action is required.




ILLEGAL OR WASTEFUL ACTIVITIES SHOULD BE REPORTED

TO THE OFFICE OF INSPECTOR GENERAL BY:

Sending written documents to:



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